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Scandal, Debt Turn Brazil's Champion Into a Cautionary Tale

(Bloomberg) -- A year into its bankruptcy saga, Oi SA is reinforcing to the rest of the world that Brazil is a hazardous place even for the most experienced of investors.

In the two decades since the telecom giant was privatized, it’s been strong-armed into disastrous acquisitions and turned into a dumping ground for the debt of its controlling shareholders. It was used by Brazil’s government to push political policies and was saddled with regulations that drained it of cash. Now, 12 months into Brazil’s biggest-ever bankruptcy protection filing, there’s still no resolution in sight.

Investors weighing whether to take a chance on Oi today should study the phone carrier’s history to understand how small groups of shareholders and a meddling government can drastically alter a Brazilian company’s fate. Non-voting shareholders who bet on Oi have seen almost $10 billion in market value evaporate and could only watch as a minority with voting power squandered the potential of a massive fiber-optic network spread out over a country larger than the continental U.S.

“Even before it was born, Oi was being plundered by controlling shareholders,” said Mauro Cunha, president of the capital markets investors association known as Amec, which fights for minority investors’ rights and counts money managers Will Landers and Luis Stuhlberger as members of its advisory board. “We’re still waiting for someone to be held accountable.”

Drowning in $19 billion in debt, Brazil’s only home-grown telecom operator is struggling to reach an accord with creditors, shareholders and potential investors. Two turnaround proposals, one in September and the other in March, were soundly rejected by bondholders.

Would-Be Investors

Would-be investors are circling, like Paul Singer’s Elliott Management Corp. and Egyptian billionaire Naguib Sawiris, offering a capital injection in exchange for a chance to take the reins. One investor, Nelson Tanure, has already built up a 7 percent stake in Oi and demonstrated how easy it is to use a small holding to gain power, seizing two out of 11 board seats so far.

“There have been a number of mistakes, from acquisitions they shouldn’t have undertaken, bad management and a lack of investment, but that’s all in the past,” said Tanure, whose Societe Mondiale fund is Oi’s second-largest shareholder. “If it’s well-managed, with healthy investments and the right alliances, Oi can once again regain the prominence in the market that should never have been lost.”

Oi’s woes go back to the company’s 1998 privatization and a pyramid holding structure that handed control of the company to a cabal of well-connected tycoons who could steer the company just by owning a small stake with voting rights. Such ownership structures, which still exist in Brazil, are a quirk that makes the country’s capital markets a minefield for uninitiated investors, said Evandro Pontes, a professor of corporate law at business school Insper in Sao Paulo.

Among early controlling shareholders were Carlos Jereissati, whose brother is a long-time politician, and Sergio Andrade, whose Andrade Gutierrez construction firm admitted last year to taking part in the sweeping bribery scheme that helped plunge Brazil’s economy into depression.

Questionable Acquisitions

Under their leadership, the telecom company (back then Oi was known as Tele Norte Leste) embarked on a series of questionable acquisitions that transferred their controlling shareholders’ debt to Oi. In 2002, Tele Norte Leste snapped up Pegasus Telecom SA, which counted the Andrade Group and Jereissati’s La Fonte group as owners, for almost 700 million reais in equity and debt. A year later, it gobbled up mobile phone operator Oi -- also controlled by Andrade and La Fonte -- and became Telemar Oi. The acquisition cost was just 1 real -- plus 4.8 billion reais in debt. Andrade and Jereissati, who left Oi’s board in 2015 and are no longer shareholders, declined to comment.

Then, in 2008, Oi agreed to buy Brasil Telecom, a rival phone company whose under-reporting of legal liability provisions tacked a surprise 1.3 billion reais onto the 5.9 billion-real price tag. Brasil Telecom’s former CEO and CFO, as well as Telemar’s investor relations head, are among executives named in an ongoing investigation into accounting mismanagement being carried out by Brazil’s national securities regulator.

The deal ushered Oi into the era of what the local media dubbed "National Champions," too-big-to-fail industry leaders that had explicit government backing. (Meatpacker JBS SA and pulp producer Fibria SA were also part of the club.) Brazil’s BNDES development bank injected 2.5 billion reais in capital to help finance the Oi-Brasil Telecom merger, while state-owned Banco do Brasil SA provided 4.3 billion reais in credit to controlling shareholders. Pension funds for state-run companies also invested.

Meanwhile, Oi’s debt ballooned from 4.4 billion reais in 2009 to 33.4 billion reais in 2012, data compiled by Bloomberg show. As Brazil’s biggest landline operator, Oi struggled under cumbersome regulations that delayed its expansion into mobile telephone service as rivals plowed ahead. As recently as last year, Oi was spending 300 million reais annually to maintain a network of 650,000 public pay-phones in places as remote as the Amazon forest that only generated 17 million reais in revenue. What’s more, for every payphone that broke and wasn’t promptly fixed, Brazil’s telecommunications regulator levied a 1 million-real fine. Oi now owes the regulator 11.1 billion reais.

But it wasn’t until 2014 that Oi made what many consider to be its most disastrous deal, merging with Portugal Telecom SGPS SA. Minority investors cried foul and tried to prevent the Andrade and Jereissati groups from voting on the transaction because it included a 4.5 billion-real debt transfer from their holding company into Oi. They also questioned Portugal Telecom’s valuation. Another surprise followed, this time in the form of almost 900 million euros of bonds from a unit of Grupo Espirito Santo held by Portugal Telecom that were defaulted on after the deal closed.

Restructuring Plan

By 2014, Oi was desperately trying to avoid filling for bankruptcy protection. It sold all its Portuguese telecom assets to billionaire Patrick Drahi’s Altice SA, and tried unsuccessfully to attract capital the following year. In June 2016, 10 days before Oi filed for bankruptcy, then-CEO Bayard Gontijo, who had been leading restructuring efforts, suddenly quit.

It’s a year last week that Oi filed for protection from creditors. Oi is considering another revision to its restructuring plan, and a vote by debt holders is supposed to take place through September. If the parties can agree on a plan -- a big if -- whoever emerges with control of the company will be entrusted with making decisions that benefit all stakeholders. Since Oi didn’t pay dividends for three years, now all of its shares have voting power. But the company could still be vulnerable to the whims of a minority with its own agenda.

“It’s very cheap to buy Oi’s control today,” said Raphael Martins, a partner of the law firm Faoro & Fucci in Rio that fought for minority shareholders’ rights in Oi. “If a restructuring succeeds to reduce the company’s indebtedness to reasonable levels, it will be a very good investment.”